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Bitcoin's future hinges on a clear legal status

MONTREAL, May 29, 2014 /CNW/ - When Mt. Gox, one of the world's largest Bitcoin exchanges, filed for bankruptcy after thousands of bitcoins went missing in February 2014, some questioned whether the cryptocurrency would be able to survive. This incident was yet another reminder that without a clear legal status, Bitcoin's growth and development is at risk. Governments around the world are paying more and more attention to the phenomenon and trying to find ways of regulating its use. This raises the question: How should Bitcoin be regulated? In a new Economic Note published today, the Montreal Economic Institute proposes some answers.

Canada is the second most popular destination for venture capital invested in Bitcoin companies, behind the United States and ahead of China. The country is currently reaping the benefits of the jobs and economic spillover that have resulted from Bitcoin entrepreneurship and innovation. However, the use of Bitcoin as a currency remains limited compared to other payment methods. "In order for it to develop its potential and be adopted by a growing number of users, clear rules are required, along with some kind of governmental acceptance," explains David Descôteaux, the author of the study.

For one thing, legislative amendments could facilitate interaction between Canadian banks and Bitcoin companies, as the former remain cautious in anticipation of more specific regulation. Worried about running afoul of existing money laundering laws in particular, several of them avoid offering banking services to Bitcoin companies, which could lead such companies to set up shop elsewhere in the future.

Yet the legal status of Bitcoin must not prevent it from being used in a manner similar to a currency; a very heavy administrative burden for users would hinder its adoption. On this point, a representative of the Finance Department recently stated before a Senate committee that these legislative modifications could include Bitcoin exchanges in the definition of money services businesses, but not individuals or other businesses, an approach that would allow for "financial innovation."

In addition to looking at the situation in Canada, the Economic Note examines how Bitcoin is faring south of the border, specifically looking at New York State's proposal to regulate exchanges with "BitLicenses," and the IRS's treatment of Bitcoin, which is causing some concern. It also touches on the far less favourable conditions that prevail in China and Russia.

When considering what steps to take in terms of Bitcoin regulation, Canada should follow the good example of Germany, which was one of the first countries to establish clear rules on the matter. "These clear rules, as well as a tax treatment that allows Bitcoin to be used as a currency, explain why the digital currency is popular in Germany and why this country was one of the first Bitcoin hubs. Canada has so far been quite welcoming to Bitcoin, and in clarifying its own regulatory framework, it should ensure that it remains so," concludes David Descôteaux.

The Economic Note entitled "How Should Bitcoin Be Regulated?" was prepared by David Descôteaux, associate researcher with the Montreal Economic Institute. This publication, as well as a technical annex, is available on our website.

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The Montreal Economic Institute is an independent, non-partisan, not-for-profit research and educational organization. Through its studies and its conferences, the MEI stimulates debate on public policies in Quebec and across Canada by proposing wealth-creating reforms based on market mechanisms.